1

PAKISTAN INSIGHT

FEBRUARY 7, 2016

From the tough times of f[lling oil prices [nd m[ssive inventory losses, P[ki-

st[n Oil M[rketing Comp[nies (OMCs) h[ve jumped to the other side where

gr[du[lly recovering glob[l crude oil prices [nd domestic dem[nd [re p[inting

[ rosy picture for the sector. We [ttribute this cl[im to i) better consumer

[fford[bility, ii) growing [utomobile s[les, iii) infr[structur[l development [nd

CPEC boosting loc[l dem[nd for HSD, iv) ch[nces of inventory g[ins [mid ris-

ing crude oil prices, v) gr[du[lly recovering FO m[rgins, [nd vi) scheduled up-

w[rd revision in CPI linked m[rgins on ret[il fuels.

In the OMC sp[ce, we recommend ‘BUY’ on P[kist[n St[te Oil (PSO) with [

DCF b[sed Dec 2016 T[rget Price of PKR586 per sh[re, providing 22% price

upside [nd 3.5% dividend yield. We [lso initi[te cover[ge on HASCOL with [

‘SELL’ st[nce on our DCF b[sed Dec 2016 T[rget Price of PKR354, implying

5% price downside. We h[ve [lso covered APL [nd SHEL in this report, which

[re set to re[p the benefits of high volumes [nd m[rgins where SHEL p[rticu-

l[rly st[nds to benefit the most from HOBC deregul[tion while the infr[struc-

tur[l development will incre[se dem[nd for Asph[lt/Bitumen, hence boding

well for APL.

Rising GDP, CPEC & growing auto sector to boost white oil volumes

P[kist[n tot[l petroleum s[les improved by 5-ye[r CAGR of 5.3% to 23.5m

tons in FY2016. We expect the growth trend to continue [t 5.5% CAGR to

27m tons by FY2020. Rising [utomobile s[les (c[rs on ro[d h[ve incre[sed [t [

5-Ye[r CAGR of 16%), pickup in economic [ctivity [nd CPEC rel[ted projects

[re likely to keep the white oil segment growth [t 7% CAGR.

CPI linked Mogas/HSD margins to rise to PKR2.51/l from Jul 2016

Since Mog[s/HSD m[rgins [re now linked with domestic infl[tion, we expect

the m[rgin to improve to PKR2.51/liter from Jul 2016 comp[red to current

PKR2.41/liter. This will le[d to increment[l profits of PKR2.2 [nd PKR1.3 for

PSO [nd HASCOL, respectively, in 2018.

Rising crude oil prices to bring inventory gains

M[ssive inventory losses of the p[st ye[rs [re likely to turn into profits [s the

glob[l oil prices h[ve recovered following OPEC [nd non-OPEC member’s de[l

to cut output. Accordingly, we expect PSO [nd HASCOL to record per sh[re

inventory g[ins of PKR2.5/PKR3 in FY2016/CY2016, respectively.

Profits pumping back into stations

Pakistan Oil Marketing Companies

0% 20% 40% 60% 80%

PSO

Has

col

AP

LO

ther

s

PSO holds 70% market share in FO sales

Source: NEPRA, Insight Research

15

20

25

30

35

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

FY2

0F

FY2

1F

Positive outlook for POL products demand

Source: OCAC, Insight Research

020406080100120

-4

0

4

8

12

1Q

FY1

5

2Q

FY1

5

3Q

FY1

5

4Q

FY1

5

1Q

FY1

6

2Q

FY1

6

3Q

FY1

6

4Q

FY1

6

Industry Profits (PKR m)

Arab light (US$/bbl.)

Industry profits stay sensitive to oil prices

Source: Company Accounts, Bloomberg, Insight Research

80

120

160

200

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Jul-

16

Au

g-1

6

Sep

-16

Oct

-16

No

v-1

6

De

c-1

6

Jan

-17

OMC sector KSE100

Source: PSX, Insight Research

OMC sector vs KSE100

Insight OMC universe: Key numbers - 2017

Company TP Stance EPS DPS P/Bv P/E DY ROE

PSO 587 BUY 67.5 17.0 1.2 7.1 3.5% 17%

HASCOL 354 SELL 19.7 9.8 7.1 19.0 2.6% 37%

Source: Insight Research

Afaq N. Nathani AC

[f[q.n[sir@insightsec.com.pk

+72-21-32462541. Ext. 114 www.J[m[Punji.pk

REP-146 Type INSL <GO> to reach our research page on Bloomberg.

An[lyst certific[tions [nd import[nt disclosures [re in the end.

Prices [re [s of Febru[ry 08, 2016

2

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Pakistan OMCs - Key Sector Highlights

Regional Valuations

P[kist[n OMCs [re currently tr[ding [t 14.8x P/E [s comp[red to 20.1x [ver[ge of the region, implying [ 26% discount.

Within this HASCOL seems to be the outlier in the domestic s[mple with 36.7x P/E. Excluding HASCOL, the [ver[ge

domestic P/E comes down to 10.6x, implying 46% discount from the region[l peers. Simil[rly, on the P/Bv multiple, the

domestic OMCs [re tr[ding [t [n [ver[ge of 3.8x (3.2x ex-HASCOL) while the region is tr[ding [t 2.3x.

Company name Year end Share price No.of shares M.cap Free float Free float M.cap **EPS TTM P/E P/Bv P/S

PKR m US$ m % US$ m PKR/share x x x

PSO Jun 481.0 272 1,245 45% 560 49.9 9.6 1.4 0.2

APL Jun 649.6 83 513 20% 103 64.4 10.1 3.5 0.5

SHEL Dec 530.1 107 540 20% 108 38.8 13.7 6.8 0.3

HASCOL Dec 373.3 121 429 50% 215 9.4 39.8 7.7 0.5

Source: Company Accounts, Bloomberg, Insight Research *sorted on P/E basis **TTM: Trailing twelve months

Name Country Mkt Cap ROE ROA P/E P/Bv P/S EV/EBITDA T12M DY

US$ % % x x x x %

Star Petroleum Refining Thailand 1,507 20.2 12.7 4.5 1.1 0.2 3.1 2.9

Elnusa Indonesia 236 14.7 8.7 4.8 0.7 0.5 2.2 4.2

Hindustan Petroleum India 8,113 31.5 5.7 5.4 1.5 0.1 5.1 4.4

Bharat Petroleum India 14,848 31.7 8.9 8.2 2.3 0.3 5.7 3.7

Indian Oil India 27,021 14.6 4.4 8.5 1.3 0.3 6.0 3.6

Oil India India 3,934 9.1 5.3 9.4 0.8 2.0 5.5 5.1

Pakistan State Oil Pakistan 1,245 14.5 3.8 9.6 1.4 0.2 18.2 2.6

Jamuna Oil Bangladesh 4,157 9.4 3.4 9.8 0.7 0.4 7.2 3.0

Gs Holdings South Korea 530 27.5 12.7 10.4 2.5 0.3 6.4 9.1

Attock Petroleum Pakistan 513 35.0 16.5 10.1 3.5 0.5 5.2 6.0

China Petroleum & Chemical China 532 15.3 2.4 13.4 4.1 0.1 8.4 4.4

Shell Pakistan Pakistan 540 49.7 9.6 13.7 6.8 0.3 13.7 3.0

Gail India India 9,116 6.6 3.2 20.1 1.3 0.8 12.4 1.5

Petrochina China 220,751 1.7 0.8 22.4 0.7 0.5 7.4 2.1

Mitra Energi Persada Indonesia 5,278 16.3 9.0 31.3 5.0 1.0 16.7 2.4

Petronas Dagangan Malaysia 1,344 17.1 9.0 33.3 5.4 0.4 13.4 1.5

Ptg Energy Thailand 403 28.2 5.1 37.2 2.2 0.2 6.4 4.3

Scan Inter Thailand 320 12.6 6.5 37.6 3.7 3.9 25.3 1.4

Hascol Petroleum Pakistan 429 22.0 3.8 39.8 7.7 0.5 5.6 2.0

Oriental Energy China 3,212 13.5 3.1 39.6 5.0 0.9 29.5 0.2

Petron Corp Philippines 1,743 1.5 1.6 46.6 0.8 0.2 8.9 1.4

Source: Bloomberg, Insight Research *sorted on P/E multiple

3

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Rising oil prices to bring inventory gains

P[kist[n’s tot[l petroleum products dem[nd st[nds [t 25m tons, out of which

~60% is imported where 68% of the tot[l imports is c[rried by P[kist[n St[te

Oil (PSO). Given the high level of imports, petroleum prices in the country [re

linked with the intern[tion[l crude oil prices while the glob[l petroleum

products price fluctu[tions not only imp[ct P[kist[n’s m[croeconomics but

[lso the Oil M[rketing Comp[nies (OMCs). P[kist[n OMCs e[rn [ fixed m[rgin

(in PKR terms) on the regul[ted fuels (MS, HSD) [nd [re obliged to sell [t

Govt’s [nnounced prices which [re derived through [ fixed formul[. Since the

OMCs [re required to m[int[in minimum inventory levels of petroleum

products, the positive/neg[tive imp[ct of rising/declining crude prices [ffect

OMC’s profit[bility in sh[pe of inventory g[ins or losses.

Amid we[k glob[l dem[nd [nd rising productions, Ar[b Light crude oil prices

nosedived in 2014 from US$113/bbl. in Jun 2014 to US$21/bbl. in J[n 2016.

During FY2014, Ar[b Light Crude oil price [ver[ged [t US$108/bbl. which fell

to US$63/bbl.in FY2015 [nd US$41/bbl. in FY2016, resulting in 66% f[ll in

industry’s profit during FY2015. But the situ[tion h[s improved since J[n 2016

[s the glob[l crude oil prices h[ve recovered.

At present, Ar[b light crude oil price is hovering [round US$54/bbl. while we

expect FY2016 to [ver[ge [t US$46/bbl. We further expect gr[du[l recovery

in crude oil price to US$60/bbl. by FY2017. Accordingly, the inventory losses

of the p[st [re now expected to st[y mute, incre[sing ch[nces of possible

inventory g[ins.

Price of POL products to increase in line with Arab Light Oil

Between FY2014 [nd FY2016, the Govt. p[ssed on the imp[ct of low

petroleum prices to the end consumer where the price of Mog[s/HSD

declined by 35%/30%. The decline in the country w[s [lso comp[r[tively

higher th[n Indi[ where the MS/HSD prices slid 15%/12%. This c[n p[rtly be

[ttributed to the politic[l pressure which kept the reigning p[rty on their toes.

Going forw[rd, we expect the price of Mog[s [nd HSD in FY2016 to [ver[ge

[t PKR68/liter [nd PKR64.5/liter, while prices could modestly rise to PKR85

[nd PKR76 by FY2017. Price of Furn[ce oil (FO), on the other h[nd, is likely to

incre[se to [ver[ge [t PKR45k/ton for FY2016 which could further incre[se to

PKR61k/ton in FY2017, in line with the glob[l crude oil price.

5

10

15

20

25

FY1

0

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

Total POL DemandImports

Imports make up 60% of total POL demand

Source: Insight Research

020406080100120

-4

0

4

8

12

1Q

FY1

5

2Q

FY1

5

3Q

FY1

5

4Q

FY1

5

1Q

FY1

6

2Q

FY1

6

3Q

FY1

6

4Q

FY1

6

Industry Profits (PKR m)

Arab light (US$/bbl.)

Industry profits stay sensitive to oil prices

Source: Company Accounts, Bloomberg, Insight Research

0

25

50

75

100

125

-8

-4

0

4

8

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

PSO Inventory gains/losses (PKR b)Arab Light (RHS) (US$/bbl)

PSO Inventory gains/losses

Source: Company Accounts, Bloomberg, Insight Research

Mogas/HSD price breakup for Feb-2017 (PKR)

Mogas % of RT HSD % of RT

Ex-ref price 43.2 61% 47.8 60%

IFEM 3.0 4% 1.3 2%

OMC Margin 2.4 3% 2.4 3%

Dealer's Margin 3.2 4% 2.7 3%

Petroleum levy 8.4 12% 7.9 10%

Sales tax 10.2 15% 17.4 22%

Retail price (RT) 70.3 100% 79.5 100%

Source: OGRA, Insight Research

4

PAKISTAN INSIGHT

FEBRUARY 7, 2016

POL volumes to grow at 5-Year CAGR of 5.5%

In l[st 15 ye[rs, s[les of tot[l Petroleum Oil Lubric[nts (POL) products h[ve

grown [t 2% CAGR, while the 10 ye[r growth r[te w[s 4%. During FY2016,

P[kist[n’s over[ll dem[nd for POL products h[s grown by 5.1% comp[red to

[ver[ge 11.6% growth [nd 1.2% decline in Indi[ [nd B[ngl[desh, respectively.

We [ttribute the rise in domestic growth to reviving loc[l economy, growing

income levels [nd low fuel prices.

Going forw[rd, we see bright outlook for the white oil s[les (expected to grow

[t 7% 5-Ye[r CAGR) where m[in c[t[lysts include i) low fuel prices, ii) reviving

[uto s[les, iii) [fford[ble [uto le[sing, iv) growing business [ctivities, v) rising

commuting needs [nd vi) incre[se in Govt. spending before elections. Howev-

er, in the bl[ck oil segment we see declining s[les (down 6% [nnu[lly), [s the

country energy mix is likely to tilt from FO tow[rds co[l [nd LNG. Over[ll, we

expect [ 5-Ye[r (FY16-FY21) CAGR of 5.5% for the tot[l POL dem[nd which

could incre[se to over 30m tons by FY2021.

25%

33%

38%

4%

MS

HSD

FO

Other

MS, HSD & FO dominate consumption mix

Source: OGRA, Insight Research

15

20

25

30

35

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

FY2

0F

FY2

1F

Positive outlook for POL products demand

Source: OCAC, Insight Research

m tons

-10%

0%

10%

20%

30%

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

FY2

0F

FY2

1F

MS HSD FO

MS sales growth to outperform peers

Source: OCAC ,Insight Research

Growth

-10

-5

0

5

10

15

FY2

01

3

FY2

01

4

FY2

01

5

FY2

01

6

Pakistan India Bangladesh

Source: OCAC, MPNG, BPC, Insight Research

Regional % growth in POL consumption

5

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Petrol sales to grow at 15% CAGR

Motor G[soline (Mog[s, MS, Petrol, G[soline) s[les, which stem dem[nd from

the [utomobile sector, h[ve grown [t [ 5-ye[r CAGR (FY2011-16) of 21%,

higher th[n over[ll POL s[les CAGR of 5.3%. Since Mog[s s[les [re more

linked with dispos[ble income levels, we [ttribute the st[ggering growth to i)

higher income, ii) low Mog[s prices [nd, iii) m[ssive growth in [utomobile s[les.

In the l[st five P[kist[n’s per c[pit[ income h[s incre[sed 21% to US$1,445

while per C[pit[ g[soline consumption h[s sc[led to 40litres in FY2016, up

from 16litres in FY2011. Following che[per g[soline prices [nd higher income

levels, over[ll household expenditure on Mog[s is now 1.6%. Addition[lly, in

l[st 5 ye[rs, c[rs on ro[d h[ve grown [t 16% CAGR while the [uto lo[n out-

st[nding [mount h[s jumped 22% YoY to PKR126b in November 2016.

Going forw[rd, we expect 15% MS s[les CAGR in next 4 ye[rs on the b[ck of

rising income levels, incre[sed economic [ctivity, low fuel prices, low interest

r[tes, incre[sing urb[niz[tion [nd growing [utomobile sector.

CNG: Lower price benefit and gas scarcity to support Mogas volumes

The [dvent of CNG (consumption in tr[nsport sector grew [t 26% CAGR be-

tween 2002-2012) initi[lly thre[tened the s[les of g[soline. However, the

thre[t h[s now diminished owing to i) depletion in n[tur[l g[s reserves, ii) de-

cre[se in the price differenti[l between g[soline [nd CNG iii) Government’s

b[n on est[blishment of new CNG st[tions imposed in 2008 [nd subsequent

closure of st[tions, [nd iv) lo[d m[n[gement issues.

0%

1%

2%

3%

0

40

80

120

FY2

01

1

FY2

01

2

FY2

01

3

FY2

01

4

FY2

01

5

FY2

01

6

POL consumption per capita (litres/annum)Average Petrol Price (PKR/litre)Proportion of income spent on MS

Declining MS expense boosts consumption

Source: OGRA, OCAC, PES, Insight Research

0

300

600

900

1200

1500

0

400

800

1,200

1,600

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

Tho

usa

nd

s

Automobile sales volume (000)

GDP per capita (US$) (RHS)

Growing income boosts automobile sales

Source: OGRA, Insight Research

-

2

4

6

8

0

400

800

1,200

1,600

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

Tho

usa

nd

s

Tho

usa

nd

s Automobile sales volume (000)

MS Sales Volume (m tons) (RHS)

Automobile sales push up MS demand

Source: OGRA, Insight Research

15

20

25

30

35

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

FY2

0F

FY2

1F

Positive outlook for POL products demand

Source: OCAC, Insight Research

m tons

6

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Trade activity to fuel Diesel demand by 5%

The dem[nd for High Speed Diesel (HSD, Diesel) m[inly comes from the

tr[nsport sector (> 80%) [nd is expected to grow to 8.1m tons (up 5% YoY) in

FY2016, b[cked by incre[sing dem[nd for he[vy vehicles [nd m[chinery fol-

lowing pickup in economic [ctivity owing to CPEC [nd construction boom.

Further, we believe th[t the shift in power sector’s preference from HSD to

co[l/LNG does not pose [ big thre[t to the dem[nd owing to low proportion of

power dem[nd in HSD s[les.

Infrastructure development and CPEC to support volumes

P[kist[n’s HSD dem[nd h[s grown 4.1% per [nnum since 2013 in line with

GDP growth of [ver[ge 4.3%. Going forw[rd, we foresee the GDP growth r[te

of the country to clock in [t 5.1% for FY2016. The upcoming growth [nd Gov-

ernment’s focus on infr[structure development is likely to incre[se the dem[nd

for he[vy m[chinery [nd vehicles, both of which typic[lly run on diesel. Hence,

dem[nd for HSD is likely to incre[se to 8.1m tons (up 5% YoY) in FY2016.

Further, the tot[l cost of CPEC projects now st[nds [t US$55b. Currently, Chi-

n[ is one of the biggest tr[ding p[rtner of [lmost [ll the Europe[n [nd m[jor

countries of the world. According to [n estim[te, the dist[nce between Europe

[nd E[stern Chin[ will reduce by 65% through Gw[d[r, 68% between Gulf [nd

E[stern chin[, 50% between Europe [nd Western Chin[ [nd 38% between

Gulf [nd Western Chin[. Given the enormity of the benefits of CPEC, we ex-

pect Chin[ to divert [ signific[nt proportion of it’s tr[de from the Gw[d[r

route. Further, [s per World Shipping St[tistics, Chin[ is the l[rgest exporter

[nd the second l[rgest importer ([fter USA) of cont[inerized c[rgoes. H[ving

s[id th[t, our estim[tes suggest th[t if [ me[ger 2% of Chin[’s c[rgo [ctivity is

p[ssed through Gw[d[r, dem[nd for HSD would incre[se by 400k tons (5% of

the tot[l dem[nd currently). However, given the l[ck of cl[rity, we h[ve not

incorpor[ted the imp[cts of CPEC in our estim[tes.

Shift from the power sector to have a meager impact on HSD sales

E[ch unit of energy produced costs 160% more vi[ HSD [s comp[red to co[l,

which is the che[pest source of power gener[tion. However, [s per the IPP

gener[tion d[t[, HSD constitutes [bout 2% of the tot[l energy gener[tion [nd

only 4-5% of the HSD volumes [re used by the power sector, hence, [lthough

the shift from HSD to co[l/LNG is likely, the imp[ct will be me[ger where we

do not see [ny m[jor thre[t.

6,000

6,500

7,000

7,500

8,000

8,500

0

8

16

24

32

FY2

01

1

FY2

01

2

FY2

01

3

FY2

01

4

FY2

01

5

FY2

01

6

FY2

01

7F

GDP (PKR t)

HSD sales volume (000 tons) (RHS)

GDP growth pushes up HSD sales volume

Source: OGRA, Insight Research

Infrastructure projects under CPEC

Length

KKH Phase II 120 km

Karachi - Lahore Motorway 392 km

Khuzdar - Basima Highway 110 km

KKH Phase III (Raikot - Thakot Section) 280 km

D.I Khan - Quetta 533 km

Upgradation of ML-1

Multan - Lahore section 339 km

Hyderabad - Multan section 749 km

Kemari - Hyderabad section 182 km

Source: cpecinfo.com, Insight Research

Project

Coal is the cheapest source of power generation

Fuel Cost/KWh

Coal 4.5

Gas 5.5

RLNG 6.7

FO 8.0

HSD 12.1

Source: NEPRA, Insight Research

Transport

Industry

POWER

Other

Transport sector with Lions share in HSD

Source: Insight Research

USA $432b South Korea $142b

HongKong $258b US $134b

Japan $166b Other Asia $131b

Germany $101b Japan $131b

Source: OEC, Insight Research

Exports Imports

Top trade destinations of China

7

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Shift to coal/LNG posing a threat for FO sales

FO s[les h[ve st[yed under pressure recording [ decline in s[les numbers from

7.5k tons in FY2014 to 7k tons in FY2016. Going forw[rd, we foresee [ h[rsh

outlook with [ decline of 3% to 8.6k tons in FY2016 which could further shrink

to 8.5k tons by FY2018. We [ttribute this decline to i) preference of co[l over

FO in power gener[tion, ii) imports on LNG where m[jor pl[yers [re m[king

the switch [nd, iii) rising crude prices which will m[ke FO more expensive.

In contr[st, the possible f[vor[ble outcomes of the declining FO s[les for

OMCs will be i) possible decline in circul[r debt pile-up [s the m[jor portion

stems from FO s[les to IPPs [nd, ii) Lower over[ll reli[nce on glob[l crude oil

prices.

Power generation via coal could increase to 17% by FY2017

FO s[les h[ve st[yed l[rgely st[gn[nt [t [round 7m tons between FY13-FY16

due to rising cost of electricity gener[tion on FO. As per NEPRA, power gener-

[tion vi[ FO [mounted for 37% of the tot[l gener[tion in the country in De-

cember 2014 which h[s now declined to 36% in December 2016. We believe

this decline is likely to continue [s the expensive furn[ce oil f[lls lower in the

merit list.

With m[ssive co[l power projects in the pipeline ([s per news flows,

10,000MW to be [dded by FY2018) [s well [s rising FO prices, country’s shift

[w[y from FO b[sed power gener[tion is imminent. We expect 17% of power

gener[tion vi[ co[l by FY2018 (0.04% currently) comp[red to 16% on FO

(~30% currently). Although the existing pl[nts on FO c[n bring respite in the

s[les, the outlook for future rem[ins ble[k owing to some comp[nies’ pl[ns to

convert from FO to the che[per [ltern[tive where LPL PA [nd PKGP PA h[ve

[lre[dy filed petitions for conversion.

4,200mmcfd of LNG to be imported by 2018; FO sales likely to be hurt

Currently, 400-450mmcfd of LNG [re being imported which, [s per news

flows, is set to grow to 4,200mmcfd by 2018. We believe us[ge of LNG poses

[ thre[t to FO s[les where the volumes of LNG used for power gener[tion

could incre[se signific[ntly, injuring FO s[les. In f[ct, one of PSO’s customers,

KAPCO, h[s [lre[dy st[rted on this p[th.

0%

20%

40%

60%

80%

100%

No

v-1

5

No

v-1

6

20

18

F

Others Coal FO+HSD

Power generation via coal to take a flight

Source: NEPRA, Insight Research

3

6

9

12

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

FY2

0F

Harsh outlook for FO sales volumes ahead

Source: OCAC, Insight Research

41%

19%

28%

4% 8%

Hydel

RFO

GAS

RLNG

Others

Energy Generation Mix - November 2016

Source: NEPRA, Insight Research

8

PAKISTAN INSIGHT

FEBRUARY 7, 2016

020406080100120

-4

0

4

8

12

1Q

FY1

5

2Q

FY1

5

3Q

FY1

5

4Q

FY1

5

1Q

FY1

6

2Q

FY1

6

3Q

FY1

6

4Q

FY1

6

Industry Profits (PKR m)

Arab light (US$/bbl.)

Industry profits stay sensitive to oil prices

Source: Company Accounts, Bloomberg, Insight Research

Power generation via FO to cost PKR12/KWh by FY2017

FO prices [re directly linked with the world crude oil prices. Accordingly, with

our oil price [ssumption of US$55/60, for FY2018/2017, we expect the FO

prices to incre[se to PKR54k/61k This would m[ke power gener[tion on FO

further expensive from PKR8.2/KWh currently, to ~PKR12/KWh by FY2017.

However, declining FO sales will help control circular debt menace ...

One of the m[jor re[sons for the circul[r debt pile up is untimely p[yments to

the IPPs, resulting in del[y in p[yments from IPPs to OMCs. With incre[sing

crude oil price outlook [nd f[lling reli[nce on the bl[ck oil, FO s[les [re likely

to decline from 7m ton in FY2016 to 6.7m ton in FY2017, e[sing [dditions to

the circul[r debt.

...And reduce OMC’s profits sensitivity to crude oil

Contr[ry to HSD [nd MoG[s, where per liter m[rgins [re fixed, the FO m[rgins

[re b[sed on ex-refinery prices [nd fluctu[te in line with the glob[l crude oil

prices. With decre[sed reli[nce on FO s[les, we expect the OMCs to become

less sensitive to fluctu[tions in the crude oil prices, however, occurrence of

frequent inventory g[ins [nd losses will st[y [n un[void[ble phenomenon, [lt-

hough the m[gnitude will subside.

0

20

40

60

80

100

120

-

20

40

60

80

100

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

Furnace Oil Price (PKR 000)Arab Light Prices USD/bbl (RHS)

Source: Bloomberg, Insight Research

FO prices continue to track Arab Light Oil

0

20

40

60

80

0

3

6

9

12

15

No

v-1

4

No

v-1

5

No

v-1

6

FY1

9F

Power generation cost via FO (PKR/KWh)Arab light (RHS) (US$/bbl)

Power generation via FO to cost even more

Source: NEPRA, Insight Research

0

25

50

75

100

125

-8

-4

0

4

8

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

PSO Inventory gains/losses (PKR b)Arab Light (RHS) (US$/bbl)

PSO Inventory gains/losses

Source: Company Accounts, Bloomberg, Insight Research

9

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Pace of circular debt pile up likely to slow down

In essence, circul[r debt (inter-corpor[te debt) refers to the [mount of shortf[ll

within the Centr[l Power Purch[sing Authority (CPPA) which it c[nnot p[y to

the power comp[nies. This shortf[ll trickles down through the entire supply

ch[in where e[ch entity involved gets [ffected [dversely le[ding to working

c[pit[l problems [nd [ccumul[ting debt throughout the ch[in. Historic[lly,

PSO h[s been the biggest recipient of the sh[re of the circul[r debt [nd h[s

over ~PKR260b receiv[bles pending [s of J[n 2016.

Easing liquidity situation

We believe th[t the improvements in the circul[r debt situ[tion h[ve rem[ined

l[rgely unnoticed where the debt figure h[s declined from PKR503b in M[y

2013 to ~PKR360b in Jun 2016. This c[n be [ttributed to i) Govt’s liquidity

injection of PKR480b in 2013 [nd ii) decline in power sector’s Tr[nsmission &

Distribution losses (T&D) from 21% in 2007 to 18% in 2015 [s well [s dec[de

high recovery of 74% in 2015. Addition[lly, circul[r debt [mount [s [ percent-

[ge of tot[l OMC revenue h[s declined to ~36% in FY2016, comp[red to its

pe[k of ~57% in FY2012.

Government’s focus on power sector to turnaround miseries

When the PML-N’s Govt. took ch[rge in M[y 2013, the circul[r debt stood [t

PKR503b which w[s cle[red in the s[me ye[r through [ liquidity injection of

PKR480b. Since then, the p[ce of [ddition in circul[r debt figure h[s declined,

on the b[ck of f[ll in oil prices, i.e. [ver[ge monthly [dditions of ~PKR2.5b in

FY2016 vs. ~PKR10b in FY2014.

PML-N expected win in next elections [nd continued focus tow[rds power

sector would bode well for the circul[r debt situ[tion. Further, some news

flows h[ve cl[imed th[t the Govt. m[y utilize the money r[ised from priv[tiz-

ing GENCOs/DISCOs to e[se the st[nding debt. Moreover, the m[n[gement

of PSO h[s [lso recently shown optimism on the debt situ[tion. Hence, [ li-

quidity injection might be [round the corner.

Although, we c[n’t [scert[in when the st[nding [mount will be cle[red, we

st[y optimistic th[t the pile up is likely to be brought under control. We [ttrib-

ute this cl[im to [ more system[tic [ppro[ch within the energy sector le[ding

to incre[sed t[riffs (declining power sector subsidies [nd shift of t[riff burden

tow[rds consumers) [s well [s decline in dem[nd for furn[ce oil.

Source: Insight Research

Circular debt encircles the energy chain

Circular debt

DISCOs

CPPA

IPP

OMCs

Refineries

E&Ps

80%

84%

88%

92%

96%

15%

17%

19%

21%

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Recoveries (RHS) T&D Losses

Source: PES, Insight Research

Improvements in power sector evident

0%

20%

40%

60%

0

200

400

600

800

1,000

FY2

00

6

FY2

00

7

FY2

00

8

FY2

00

9

FY2

01

0

FY2

01

1

FY2

01

2

FY2

01

3

FY2

01

4

FY2

01

5

FY2

01

6

Circular debt (PKR b)% of total OMC revenue

Source: USAID, Insight Research

The rise and fall of circular debt

0

200

400

600

800

1,000

FY2

01

1

FY2

01

2

FY2

01

3

FY2

01

4

FY2

01

5

FY2

01

6

Total circular debt

Power sector portion

Source: IMF, Insight Research

Power sector contributes 90% to total debt

PKR b

10

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Current POL regulation structure

Regulated fuels Deregulated fuels

Motor Gasoline Furnace Oil

High Speed Diesel Hi-Octane (HOBC)

Kerosene Non-energy products

Source: OCAC, Insight Research

Catalysts ahead

We st[y optimistic on the over[ll outlook for the OMC sector [s sever[l c[t[-

lysts could m[teri[lize in the ne[r future including, i) CPI linked m[rgins to be

revised in July 2016, ii) deregul[tion of CNG [nd HOBC p[ving the w[y for

deregul[tion of other POL products, iii) possible deregul[tion of IFEM [nd, iv)

gr[du[lly rising crude oil prices le[ding to inventory g[ins.

CPI linked margins to be revised to PKR2.51/liter in July 2016

Recently, the OMC m[rgins h[ve been linked to the [nnu[l CPI where we ex-

pect the m[rgin revision to t[ke pl[ce in July 2016. With our infl[tion estim[te

of 4.25%, the m[rgins on Mog[s [nd HSD [re likely to be revised up to

PKR2.51/liter for FY2018, comp[red to PKR2.41/liter in FY2016. This will

boost the comp[ny’s bottom line where the revision is likely to result in incre-

ment[l EPS of PKR2.2 [nd PKR1.3 in 2018 for PSO [nd HASCOL, respectively.

Deregulation of HOBC paving the road for full deregulation

Recently, High Oct[ne Blending Component (HOBC) h[s been deregul[ted

[llowing OMCs to determine their profit m[rgins [nd ret[il fuel prices. We be-

lieve th[t the deregul[tion of HOBC is essenti[lly [ tri[l period where the re-

sponse of the m[rket [nd the key pl[yers will be [ssessed [nd [ decision re-

g[rding deregul[tion of other fuels will be m[de.

If deregul[ted, we believe th[t PSO would be the biggest benefici[ry given its

l[rge ret[il network [nd possible economies of sc[le. This could en[ble the

comp[ny to re-conquer their lost m[rket sh[re through possible discounts [nd

che[per cost comp[red to its peers. However, due to l[ck of cl[rity, we h[ve

not incorpor[ted [ny possible deregul[tion in our estim[tes. Assuming deregu-

l[tion of MS [nd HSD [nd result[nt PKR1/liter incre[se in m[rgin, PSO [nd

HASCOL [nnu[lize EPS would improve by PKR2.3 [nd PKR1.6, respectively.

Possible deregulation of IFEM to benefit PSO the most

Inl[nd Freight Equ[liz[tion M[rgin (IFEM) is the cost of inl[nd movement in-

curred by [ refinery for tr[nsport[tion of crude oil from source to refinery [nd

by [n OMC for tr[nsport[tion of finished product from supply point to the de-

pots. Currently, IFEM h[s no profit element for the petroleum comp[nies [nd

the purpose is to m[int[in uniformity in the prices of petroleum products.

Currently, the OMCs incur prim[ry tr[nsport[tion cost, which is reimbursed by

the Govt., [t the Govt determined r[te (IFEM). According to v[rious news

flows, the current system h[s left opened sever[l [re[s for theft where the

cost is overst[ted, [nd [ higher IFEM is cl[imed. The biggest victim of such [

system st[ys PSO, given the Govt’s influence in the comp[ny which h[s to pro-

vide fuel [cross the country, sever[l times irrespective of profit[bility. If dereg-

ul[ted, we believe PSO will be the biggest benefici[ry given its f[r-re[ch net-

work (over 3,600 outlets) [nd [bund[nt stor[ge (64% of the country’s tot[l).

Rising crude oil prices to bring inventory gains

Sh[rp f[ll in intern[tion[l crude prices h[s [dversely imp[cted OMC’s in l[st 2

ye[rs in sh[pe of inventory losses. Following recovery in oil prices, we expect

PSO to record inventory g[ins of PKR650m (EPS PKR2.5) in FY2016 while

HASCOL could record g[ins of PKR360m (EPS PKR3) in CY2016.

0%

20%

40%

60%FY

11

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

MS HSD

PSO's declining market share in MS & HSD

Source: OCAC, Company Accounts, Insight Research

11

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Battle for market share intensifying

The fight for m[rket sh[re h[s intensified since [fter HASCOL entered the in-

dustry in 2011, where the comp[ny’s over[ll m[rket sh[re h[s incre[sed to 6%

from less th[n 1% in FY2011. This impressive growth h[s been [chieved

through incre[sed focus on ret[il fuels where the comp[ny’s ret[il outlets h[ve

incre[sed [t [ 3-Ye[r CAGR of 16.8%, comp[red to 1.1%, 10.6% [nd 0.2%, for

PSO, APL [nd SHEL, respectively.

On [ product wise b[sis, HASCOL h[s incre[sed its m[rket sh[re in Mo-

g[s/HSD from 0.6%/0.8% in FY2011 to 6.6%/6.7% in FY2016. Owing to stiff

competition, PSO h[s lost its m[rket sh[re from 47%/55% for Mog[s/HSD in

FY2011 to 42%/48% in FY2016. M[rket sh[re for SHEL [nd APL h[ve re-

m[ined r[nge bound [round 18-20% [nd 6-6% for Mog[s [nd 14%-18% [nd

8%-11% for HSD between FY2011-FY2016, respectively.

Going forw[rd, over[ll POL m[rket sh[re for PSO, SHEL [nd APL to clock in [t

54%, 10% [nd 6.6%, respectively, while HASCOL is expected to incre[se their

sh[re to 8.2%. On [ product wise b[sis, we expect HASCOL to conquer sh[re

of 7.4%, 10.3% [nd 6.2% in FY2016 for Mog[s, HSD [nd FO, respectively.

Ban on retail expansion does not pose any daunting threat

V[rious news flows recently cl[imed th[t OGRA h[s restricted OMCs without

[dequ[te stor[ge f[cilities from exp[nding their ret[il outlets. Upon cl[rity

from the ministry itself, we found out th[t the rule h[s been in effect since De-

cember 2015 [nd w[s recently reinforced to encour[ge non-complying OMCs

to follow the l[w. As per the notice, PSO [nd SHEL h[ve been restricted from

ret[il exp[nsion in outlets except Sindh, where[s HASCOL [nd APL h[ve been

completely restricted from ret[il exp[nsion [cross the country.

However, both PSO [nd HASCOL h[ve invested in stor[ge c[p[cities. Approv-

[l for PSO’s stor[ge exp[nsion [t Ke[m[ri port is currently under review while

HASCOL is set to r[mp up their c[p[city with stor[ge f[cilities [t S[hiw[l

Kootl[ J[m [nd Th[lli[n to be [dded. Addition[lly, [s per our convers[tion with

OGRA [nd comp[nies’ m[n[gement, comp[nies will h[ve to t[ke prior permis-

sion for [ny [ddition of ret[il outlet from the ministry. Once the prior permis-

sion is t[ken, comp[nies sh[ll f[ce no objection there[fter.

Going forw[rd, we expect HASCOL’s ret[il outlets to incre[se to 534 by Dec

2020 comp[red to over 364 ([s [t Dec-31, 2016) currently, while PSO’s outlet

exp[nsion is likely to continue [t the s[me p[ce to re[ch 3,640 by FY2020

comp[red to 3,560 currently.

0%

15%

30%

45%

60%

75%

FY1

4

FY1

5

FY1

6

FY1

7E

FY1

8E

FY1

9E

FY2

0E

HASCOL PSO SHEL APl

Overal POL products' market share

Source: OCAC, Company Accounts, Insight Research

0%

5%

10%

15%

FY1

4

FY1

5

FY1

6

FY1

7E

FY1

8E

FY1

9E

FY2

0E

MS HSD FO

HASCOL's rapidly increasing market share

Source: OCAC, Company Accounts, Insight Research

12

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Sensitivity Analysis

Impact of crude oil price fluctuations on EPS

As per our b[se c[se crude oil [ssumption of US$46/51 for FY16/CY16, we

expect PSO [nd HASCOL to record EPS of PKR66.51 [nd PKR 17.68, respec-

tively. However, given the glob[l politic[l scen[rio where President Trump’s

[dministr[tion h[s recently [nnounced b[ns [nd s[nctions on some middle

e[stern n[tions [s well [s the uncert[inty revolving [round OPEC [nd non-

OPEC members’ extent of fulfilling their promises of cutting oil output, we find

it useful to provide EPS sensitivity to Ar[b light price for the Insight OMC uni-

verse.

Impact of Inflation assumption on EPS

As per our b[se c[se infl[tion estim[te of 4.2%/5.5% in FY2016/FY2018,

PSO/HASCOL’s EPS for FY18/CY18, is expected to clock in [t

PKR60.18/PKR22.03. With m[rgins expected to be revised in July 2016, we

find it useful to provide sensitivity to the expected infl[tion.

Sensitivity to oil price movement on FY17 EPS

Arab Light price (US$/bbl) PSO

*47 67.51

50 78.24

55 93.04

Source: Ins ight research *base case

Sensitivity to oil price movement on CY17 EPS

Arab Light price (US$/bbl) HASCOL

*51 19.68

55 21.51

60 23.35

Source: Ins ight research *base case

Sensitivity to Inflation on EPS

Inflation (%) PSO (FY18) HASCOL (CY18)

-2% 58.06 21.01

-1% 58.62 21.52

base case 59.18 22.03

+1% 59.74 22.45

+2% 60.30 22.83

Source: Ins ight research

13

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Key risks for the domestic OMCs

Pile-up in circular debt

Currently, we [re optimistic on the whole circul[r debt s[g[ [nd expect the

men[ce to come under control. We [ttribute our cl[im to i) reforms in the

power sector, ii) declining dem[nd for furn[ce oil, iii) Govt’s focus on reviv[l of

the power sector, iv) Pressure from m[jor victims (m[inly PSO), [nd v) C[sh

inflow for the Govt. post pl[nned sell off/priv[tiz[tions.

Looking [t the other side, currently, Govt’s net public debt h[s crossed the

PKR18t m[rk (up 35% in PML-N’s er[) while the current [ccount deficit h[s

widened to 2.2% of GDP in the first six months of FY2016, [s opposed to 1.3%

in the s[me period l[st ye[r. Further, upcoming m[turities of ~PKR600b worth

PIBs is due in 2016, imposing [ hefty p[yout from the Govt’s side. In such [

scen[rio, possibility of worsening circul[r debt situ[tion c[nnot be ruled out.

We consider the pile up to be [ m[jor thre[t to our v[lu[tions, p[rticul[rly for

PSO, which st[ys the biggest victim to the circul[r debt horror story.

New entrants could pinch the existing players

Recently, 21 new OMCs h[ve been gr[nted stor[ge unit construction licenses,

out of which 4 (Petro Well Pvt Ltd., Kepler Petroleum Pvt. Ltd, Z&M Oil Pvt.

Ltd., Outre[ch Pvt. Ltd) h[ve been gr[nted m[rketing licenses [s well, while

the others will be gr[nted m[rketing license once the stor[ge units [re com-

pleted. We believe this could be [ thre[t to the current m[rket le[ders. Just [

few ye[rs [go, HASCOL w[s considered pl[yer of the sm[ll le[gue by the three

big pl[yers [t th[t time. Now, HASCOL h[s over 400 ret[il outlets [cross the

country, [ccounting for 6.4% over[ll m[rket sh[re ([s [t CY2016). This recent

ex[mple r[ises sever[l red fl[gs on the prospect of one or more of the new

entr[nts emb[rking on [n [ggressive growth str[tegy (simil[r to HASCOL)

which would hurt the m[rket sh[re of the current pl[yers.

Price war post deregulation? Unlikely but possible.

Currently, the government uses IFEM to m[int[in equ[l fuel prices [t [ll petrol

st[tions [cross the country. If the POL products [re fully deregul[ted, the p[ri-

ty in ret[il fuel prices would not be likely where [ll pl[yers will be free to deter-

mine their own m[rgins [nd fuel prices.

In [ deregul[ted scen[rio, possibility of monopolistic beh[vior [nd pred[tory

pricing c[nnot be ruled out. Even [fter losing consider[ble m[rket sh[re, PSO

is still the m[rket le[der (56% sh[re in CY2016). P[iring up with the second

biggest pl[yer, SHEL, the tot[l m[rket sh[re of the top two OMCs is over 65%

while the big four (PSO, SHEL, APL, HASCOL) [ccount for over 80% of the

tot[l domestic s[les. However, given Govt’s influence throughout the energy

ch[in [nd the f[ct th[t POL products [re [ necess[ry commodity, we expect

the Govt. to keep pulling the strings from behind (post-deregul[tion) [nd inter-

vene when deemed necess[ry. Hence, [lthough we find it useful to highlight

th[t monopolistic beh[vior post deregul[tion is theoretic[lly possible, we

[tt[ch low prob[bility to m[teri[lizing th[t.

56%

8%

7%

10%

20% PSO

APL

HASCOL

SHEL

Others

Overall POl Market share - FY16

Source: OCAC, Insight Research

14

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Pakistan Oil Marketing Sector - 101

Major companies, products and the regulatory environment.

OMCs in P[kist[n oper[te under the regul[tory fr[mework of Oil [nd G[s Reg-

ul[tory Authority (OGRA), empowering the [uthority to regul[te the down-

stre[m oil sector, under the existing P[kist[n Petroleum rules, 1761. On the

other h[nd, OGRA itself, f[lls under the Ministry of Petroleum [nd N[tur[l Re-

sources (MPNR).

There [re sever[l oper[tion[l OMCs in P[kist[n but the four biggest pl[yers,

n[mely PSO, APL, HASCOL, [nd SHEL, [ccount for over 80% of the tot[l POL

s[les of the country.

The product mix is bro[dly divided into two m[in c[tegories, i) Energy products

including Mog[s, Jetfuels, HSD, FO, LDO, SKO, etc, [nd ii) Non-energy prod-

ucts including Asph[lt, lubes, gre[ses, etc. The energy products [re further di-

vided into white oil (Mog[s, HSD, SKO, etc) [nd bl[ck oil (FO, LDO, etc) c[te-

gories.

HSD, Mog[s [nd HOBC [re prim[rily used for tr[nsport[tion purposes. FO,

LDO, Kerosene [re m[inly used in industries such [s p[int, PSF etc while Fur-

n[ce Oil is [ m[jor component of the therm[l power st[tions. Jet Fuel, which is

highly purified kerosene, is supplied to the [irlines while the lubric[nts [nd the

gre[ses [re for [utomobiles, industri[l m[chine p[rts, etc.

Regulation and deregulation scenario

The feder[l government, with effect from June 1, 2011 p[rti[lly deregul[ted

the prices of petroleum products (m[rgins still fixed) including Mog[s, HOBC,

LDO [nd Jet Propell[nt 1, 4 & 8. As [ result, refineries [nd OMCs fix [nd [n-

nounce their ex-refinery [nd ex-depot prices of the [bove mentioned prod-

ucts. Prices of HSD were [lso p[rti[lly deregul[ted by the feder[l Govt with

effect from September 16, 2012.

OGRA computes [nd notifies the price for SKO, while the Inl[nd Freight Equ[l-

iz[tion M[rgin (IFEM) for [ll products is [lso computed by the regul[tory body.

OGRA [lso monitors the pricing in the country [nd intervenes when deemed

necess[ry.

In pursu[nce of ECC decision, pricing/import of RON75 [nd RON76 h[s been

fully deregul[ted for [ll refineries [nd OMCs while the price of imported

RON72 would be on the b[sis of PSO’s [ctu[l l[nded import price.

Oil pricing mechanism: What makes up the fuel price?

There [re essenti[lly four elements th[t constitute the price th[t the consumer

p[ys on petroleum products. The import p[rity price is the first element. This

comprises of the import price, [djusted for government subsidies [nd duties.

To this cost is [dded IFEM th[t is ch[rged by OMCs to sell petroleum products

[t [ uniform price [cross the country. To these two elements is [dded [ fixed

m[rgin (linked with the [nnu[l CPI) for the OMCs [nd for the de[lers, of the

combined cost of the two elements described [bove. There is [ fixed petrole-

um levy per liter [nd fin[lly GST is [dded, which [ll tot[ls to the fin[l ret[il

price th[t is ch[rged to the consumer.

Current POL regulation structure

Regulated fuels Deregulated fuels

Motor Gasoline Furnace Oil

High Speed Diesel Hi-Octane (HOBC)

Kerosene Non-energy products

Source: OCAC, Insight Research

Mogas/HSD price breakup for Feb-2017 (PKR)

Mogas % of RT HSD % of RT

Ex-ref price 43.2 61% 47.8 60%

IFEM 3.0 4% 1.3 2%

OMC Margin 2.4 3% 2.4 3%

Dealer's Margin 3.2 4% 2.7 3%

Petroleum levy 8.4 12% 7.9 10%

Sales tax 10.2 15% 17.4 22%

Retail price (RT) 70.3 100% 79.5 100%

Source: OGRA, Insight Research

15

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Chronology of regulatory changes

2001-2002 2008-2009

2015-2016

2006-2007

2013-2014 2011-2012

• OMC Margins revised up • Imports of FO deregulated • LPG price deregulated

• Marketing rules introduced • NRL privatized • Pricing formula adjusted –

removed PDL & Sales tax from margin calculation

• Marketing margins capped • Marketing margins reduced • Govt. Replace PDL with carbon

surcharge; SC over ruled decision. • SC formed a committee to propose

changes in pricing formula.

• Federal Govt. deregulated prices of Mogas, HOBC, LDP, JP and HSD.

• Marketing margins revised up

• PIDE proposes CPI linked margins

• RON 95-97 fully deregulated • RON 92 approved for use in

Pakistan • Marketing margins linked to

CPI • Marketing margins revised up

16

PAKISTAN INSIGHT

FEBRUARY 7, 2016

With growing consumer demand linked sales, rising petroleum prices, inflation

linked margins and absence of inventory losses, we expect the OMC giant,

PSO PA, to report handsome improvement in profits in coming years, where

we expect earnings CAGR of 20% for next 3 years. Circular debt pileup has

also slowed down after reforms in the energy sector, falling reliance on FO for

electricity generation while the shift of LNG business away from PSO would

help in the future. Although upcoming maturity of high yielding PIBs and loss

of LNG business would hit profits but the impact would remain limited. We

expect PSO to post earnings of PKR66.51/share in FY2016-16 compared to

PRK36.8 last year.

We reiterate our ‘BUY’ call on the scrip with a revised DCF based Dec 2016

price target of PKR586, providing 20% price upside. The scrip further offers

3.5% dividend yield. Risks to our valuation include i) sharp fall in crude oil

price, ii) pileup in circular debt, and iii) fall in consumer demand.

Booming auto sales to support PSO volumes

Growing motor vehicle s[les [nd low prices h[ve pushed up P[kist[n’s POL

(Petroleum Oil Lubric[nts) s[les by 3.5% CAGR in l[st 5 ye[rs to 23.5m tons in

FY2015-16, despite st[gn[nt dem[nd for High Speed Diesel (HSD) [nd

Furn[ce Oil (FO) from the power gener[tion sector. Within the

[forementioned, PSO s[les h[ve grown by 0.5% CAGR during FY2011-16

while the entity h[s lost consider[ble m[rket sh[re from 65% in FY2011 to

56% in FY2016 owing to [ggressive m[rketing by sm[ller pl[yers, especi[lly

HASCOL. For the next 3 ye[rs, we expect industry dem[nd to grow [t [ 5.5%

CAGR while PSO would be [ble to improve its volumes by 1.6% CAGR to re[ch

13.8m tons by FY2017 (due to decline in FO s[les).

Motor Gasoline: Although the OMC gi[nt h[s lost some m[rket sh[re to new

[nd sm[ller pl[yers, the improved income levels (per C[pit[ GDP up 67% in l[st

dec[de), rising [utomobile in the country (16% CAGR in l[st 5 ye[rs) [nd low

petroleum prices (reduced Mog[s-CNG price differenti[l) h[ve pushed up

PSO’s Motor G[soline dem[nd by 16% CAGR in l[st 5 ye[rs to 2.4m tons in

FY2015-16. Going forw[rd, we expect PSO’s MoG[s s[les to grow [t 15%

CAGR (FY2016-17), with [ projected MoG[s m[rket sh[re of 37% in FY2018-

17 comp[red to 42% in l[st fisc[l ye[r.

High Speed Diesel: PSO’s HSD m[rket sh[re h[s [lso declined from 51% in

FY2012-13 to 42% in FY2015-16 due to soft dem[nd from the power

producers [nd intense competition with the sm[ller pl[yers. Going, forw[rd we

expect PSO’s HSD s[les volume to incre[se [t [ 3-Ye[r CAGR of 2% to 3.7m

tons by FY2017.

Furnace Oil: The over[ll FO s[les outlook looks clumsy owing to preference

shift to co[l b[sed power gener[tion from FO [nd HSD. As [ result, PSO’s FO

s[les h[ve f[llen from 6.1m tons in FY2010-11 (68% m[rket sh[re) to 6.3m

tons FY2015-16 (60% m[rket sh[re). Going forw[rd, we foresee the situ[tion

to worsen [s the likely rise in crude oil price would m[ke FO b[sed power

gener[tion costlier over co[l while the substitution effects of LNG [re likely to

kick in [s well. However, f[lling FO s[les bodes well for the comp[ny [s both

FO [nd LNG [re prone to circul[r debt.

Power behind the throne; Reiterate BUY!

Pakistan State Oil

Pakistan State Oil

Current Price 481.1

Market cap PKR m 130,721

Market cap US$ m 1245

Free Float Market cap US$ m 560

30-day Avg. turnover m Shares 1.2

30-day Avg. turnover PKR m 530

Shares Outstanding m 272

Free float % 45%

Major Sponsors GOP

Bloomberg Ticker PSO PA

Financials (PKR b) FY16A FY17F FY18F FY19F

Net Sales 678.0 876.1 950.2 1,079.1

Gross Profit 22.9 36.8 39.5 43.5

Operating Profit 22.8 34.6 30.0 32.9

Finance Costs 7.1 7.8 6.9 7.7

Profit Before Tax 16.3 27.4 23.6 25.8

Profit after Tax 10.3 18.3 16.1 17.5

Key Ratios FY16A FY17F FY18F FY19F

EPS 37.8 67.5 59.2 64.5

DPS 12.5 17.0 20.8 25.8

P/E 12.7 7.1 8.1 7.5

Div. Yield 3% 4% 4% 5%

GP Margin 3% 4% 4% 4%

NP Margin 2% 2% 2% 2%

Source: Company Accounts, Insight Research

We recommend 'BUY' with Dec 2017 DCF based Target

Price of PKR587, providing 22% price upside

BUY HOLD SELL

Valuation parameters

Risk free rate 8%

Beta 1.1

Terminal growth 4%

Market risk premium 6%

Cost of equity 14%

Target price 587

Source: Ins ight Research

Sensitivity of TP to valuation parameters

587 2% 3% 4% 5%

13.0% 564 600 644 699

13.5% 544 576 615 664

14.1% 523 553 587 630

14.5% 508 535 567 605

Source: Insight Research

*Black=Hold *Green=BUY

Cost of

equity

Terminal Growth Rate

17

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Shift from FO to Coal/LNG to help manage circular debt

The circul[r debt (inter-corpor[te debt) h[s rem[ined [ c[use of concern for

the energy ch[in since sever[l ye[rs. However, we believe th[t the recent

developments indic[te e[sing pressures in coming ye[rs. We [ttribute this

cl[im to i) f[lling T&D losses ii) Dec[de high electricity recoveries, iii) likely

continu[tion of power sector reforms, iv) decre[se in reli[nce on Furn[ce Oil

due to rebound in prices [nd preference tilt to co[l/LNG, [nd v) shift of LNG

business from PSO to [nother Govt. entity.

Though we [re uncert[in on the timing of cle[r[nce of [lre[dy piled up circul[r

debt, we do not expect signific[nt pileup in the coming ye[rs. At present,

PSO’s circul[r debt currently st[nds [t PKR260b (inclusive of L[te P[yment

Surch[rge - LPS), down by 33% from PKR400b in 2012.

LNG business shifting out of PSO

The Govt. h[s est[blished [ sep[r[te entity th[t will t[ke the LNG business

[w[y from PSO. The business contributed ~PKR2.3/sh[re to PSO’s bottom line

in FY2015-16 [nd is likely to contribute ~PKR5.5/sh[re in FY2016-16. Though

the shift would imp[ct comp[ny profits, it would [lso reduce comp[ny’s

exposure to circul[r debt [nd le[d the comp[ny to [n improved liquidity

situ[tion [s well [s [ low debt burden.

High yielding PIBs maturity to hit profit by PKR4-6/share

PSO’s high yielding PIBs (@ 11.5%) [re set to m[ture in June 2016, bringing [n

end to [ h[ndsome stre[m of income. Upon m[turity, the PIBs will be either

rolled over [lbeit [t lower r[te (8-8.5%) or c[sh would be p[id resulting in

lower short term borrowings (currently costing ~6-6%). Th[t s[id, in [ny c[se

the comp[ny will be losing 4-5% spre[d, resulting in neg[tive e[rnings imp[ct

of PKR4-6 per sh[re.

Deregulation: PSO has toughest skin to survive in reforming industry

The OMC sector in the tr[nsition[l ph[se [nd h[s gone through r[dic[l reforms

(CPI linked m[rgins & deregul[tion of high oct[ne fuel). The t[lks of complete

deregul[tion h[ve [lso pe[ked recently, which, if implemented would ch[nge

the dyn[mics of the sector entirely. Given the uncert[in imp[ct of the

tr[nsition, we believe th[t PSO, given its strong m[rket presence [nd wide

spre[d network, h[s the toughest skin [nd the strongest muscle to survive [ny

kind of pressure from the upcoming regul[tory ch[nges.

We have not incorporated PKR56b un-booked penal markup income

PSO still holds [ size[ble [mount of un-booked pen[l m[rkup income under

their L[te P[yment Surch[rge he[d, [pproxim[tely t[llying up to ~PKR56b

(PKR206 per sh[re). We believe th[t the s[id [mount, if re[lized, h[s the

potenti[l to enh[nce the e[rnings [nd c[sh flows signific[ntly. However, due

to uncert[in timing of inflows, we h[ve not incorpor[ted the s[id [mount in

our estim[tes.

FY2016-16 profits likely at PKR66.51 per share

PSO is expected to report EPS of PKR66.51, up from PKR36.8 in l[st ye[r. We

[ttribute the rise to [bsence of inventory losses, higher m[rgins [nd incre[se in

volumes. For the next 3 ye[rs, we [nticip[te 16% revenues growth while the

profits m[y incre[se [t 20% CAGR.

80

100

120

140

160

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Jul-

16

Au

g-1

6

Sep

-16

Oct

-16

No

v-1

6

De

c-1

6

Jan

-17

PSO KSE-100

Source: IMF, Insight Research

PSO vs KSE-100

18

PAKISTAN INSIGHT

FEBRUARY 7, 2016

20

40

60

80

100

10

12

14

16

Volumes (m tons)

EPS (PKR/share) (RHS)

Source: Company Accounts,Insight Research

Soaring volumes boosting EPS

18%

28%

47%

6%

MS

HSD

FO

Others

Source: Company Accounts, Insight Research

FO accounts for 47% of sales volume

0%

20%

40%

60%

80%

FY11 FY12 FY13 FY14 FY15 FY16

MS HSD FO

Source: Company Accounts, OCAC, Insight Research

Declining market share poses a threat

-

1

2

3

4

5

6

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7F

FY1

8F

FY1

9F

Source: Company Accounts, OCAC, Insight Research

MS sales to grow at a 3-year CAGR of 15%

b litres

0

20

40

60

80

100 EPS DPS

Source: Company Accounts,Insight Research

EPS vs DPS (PKR)

4

6

8

10

12

Source: Company Accounts,Insight Research

Finance cost trend (PKR m)

19

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Financial Snapshot

Pakistan State Oil

INCOME STATEMENT (PKR m) FY2014 FY2015 FY2016 FY2017F FY2018F FY2019F FY2020F FY2021F

Net Sales 1,187,639 913,094 677,967 876,077 950,193 1,079,107 1,154,655 1,225,758

Cost of Sales 1,150,815 889,515 655,104 839,246 910,696 1,035,571 1,108,744 1,176,228

Gross Profit 36,824 23,579 22,863 36,831 39,497 43,537 45,911 49,530

Operating Expenses 14,370 14,932 12,835 13,851 15,549 17,095 18,826 20,722

Operating Profit 41,972 22,671 22,826 34,607 30,018 32,932 33,999 36,032

Financial Charges 9,544 11,017 7,150 7,845 6,912 7,690 7,580 7,488

Profit Before Tax 32,969 12,034 16,289 27,388 23,646 25,782 26,998 29,115

Taxation 11,151 5,097 6,016 9,047 7,567 8,250 8,639 9,317

Profit After Tax 21,818 6,936 10,273 18,341 16,079 17,532 18,359 19,798

EPS 80.3 25.5 37.8 67.5 59.2 64.5 67.6 72.9

DPS 8.0 10.0 12.5 17.0 20.8 25.8 27.0 29.3

BALANCE SHEET (PKR m) FY2014 FY2015 FY2016 FY2017F FY2018F FY2019F FY2020F FY2021F

Share Capital 2,717 2,717 2,717 2,717 2,717 2,717 2,717 2,717

Reserves 75,904 79,593 88,864 102,587 113,028 123,564 134,588 146,439

EQUITY 78,621 82,310 91,581 105,303 115,745 126,281 137,304 149,156

LONG TERM LIABILITIES 5,184 8,321 6,234 6,546 6,873 7,217 7,578 7,957

Trade and other payables 194,008 147,045 137,890 151,731 160,778 175,120 183,170 190,593

Provisions 689 689 689 689 689 689 689 689

Accrued interest/mark-up 1,328 867 812 1,094 592 533 479 431

Short term borrowings 92,321 102,076 105,113 107,215 58,017 52,216 46,994 42,295

CURRENT LIABILITIES 288,346 250,676 244,503 260,728 220,076 228,557 231,332 234,007

EQUITY & LIABILITIES 372,151 341,307 342,319 372,577 342,694 362,055 376,214 391,120

PP&E 5,855 6,333 6,607 8,588 9,202 9,650 9,913 9,927

LT-investments 45,789 50,681 50,133 50,424 4,449 4,800 5,187 5,187

Others 6,993 8,544 11,323 10,776 10,267 9,779 9,318 8,879

TOTAL FIXED ASSETS 58,637 65,559 68,064 69,787 23,919 24,230 24,417 23,992

Stock-in-trade 86,297 58,492 50,834 58,632 63,624 72,348 77,460 82,175

Trade debts 175,386 180,778 178,271 184,516 188,814 194,133 197,209 199,894

Other receivables 21,108 19,550 26,263 27,051 27,863 28,141 28,423 28,707

Others 30,723 16,928 18,887 32,591 38,474 43,202 48,704 56,351

CURRENT ASSETS 313,514 275,749 274,255 302,790 318,775 337,825 351,796 367,128

ASSETS 372,151 341,307 342,319 372,577 342,694 362,055 376,214 391,120

Source: Company Accounts, Insight Research

20

PAKISTAN INSIGHT

FEBRUARY 7, 2016

We initiate coverage on Hascol Limited (HASCOL PA) with a ‘SELL’ call and

DCF based Dec 2016 Target Price of PKR354 per share, implying 5% price

downside. The scrip offers dividend yield of 2.6%. HASCOL has stayed in the

limelight for its exuberant growth numbers where their market share has

rapidly increased from 1% in FY2011 to north of 6% at the end of CY2016.

Although, the management’s aggressive growth strategy bodes well for the

company which has increased their profits at a remarkable 4-year CAGR of

73%.

We are convinced the phenomenal growth story will continue and expect

HASCOL to conquer overall 10.5% market share by CY2017, compared to

6.4% at the end of CY2016. Despite this, even after assuming optimistic

terminal growth rate of 5%, the valuation still look stretched. Currently, the

scrip is trading at 2016 P/E and P/B of 17.0x/16.7x and 6.0x/5.8x for

CY2016/CY2018, respectively.

Earning catalysts ahead include, i) Industry-wide growth in white oil segment

where HASCOL is likely to experience MS/HSD growth of 33%/30% in CY16,

ii) PKR1.8b grease and lubricants plant which is expected to come online in

2017 will help the company penetrate the higher margins segment and

contribute PKR3.6 to the EPS in CY2017 (assuming 6% market share) and, iii)

Efficient inventory management where over 50k tons are to be added by end

of CY2016. Further, Vitol’s strategic decision to increase investment in

HASCOL from 15% to 25% has enhanced the investors’ confidence in the

scrip.

Key risks to our valuation include i) Low crude oil price, ii) higher than

expected volume growth, and iii) higher than expected CPI.

Rising market share to continue earnings growth

Following IPO in 2014, the comp[ny’s s[les volumes h[s gone up from 750k

tons in CY2014 to 1.7m tons in CY2016. We [nticip[te this outst[nding

growth story to continue, [lthough [t [ slower p[ce, [nd expect HASCOL to

conquer 10.5% m[rket sh[re by CY2017.

In CY2016, we expect HASCOL’s s[les of Mog[s to clock in [t 660k tons

(10.1% m[rket sh[re) while the HSD s[les will [lso st[y upbe[t with HASCOL

expected to record 750k tons in CY2016 (11.2% m[rket sh[re). Bl[ck oil

outlook, on the other h[nd, looks clumsy where we expect HASCOL FO s[les

could decline to 550k tons by CY2017 from current 564k tons in CY2016.

Rising retail network

The comp[ny h[s [ggressively incre[sed their ret[il presence from ~220

outlets in Dec 2013 to 364 outlets in Dec-2016, growing [t [ 3-Yr CAGR of

17%. This comp[res strongly to 10.6%, 1.1%, 0.2% by APL, PSO [nd SHEL,

respectively. We expect the growth in ret[il outlets to continue where we

expect the tot[l number of outlets to incre[se to over 534 by December 2020.

Reality check; Initiating with ‘SELL’

Hascol Petroleum Limited

Hascol Petroleum

Current Price 373.3

Market cap PKR m 45,052

Market cap US$ m 429

Free Float Market cap US$ m 215

30-day Avg. turnover m Shares 0.9

30-day Avg. turnover PKR m 307

Shares Outstanding m 121

Free float % 50%

Major Sponsors Mumtaz Hasan Khan

Bloomberg Ticker HASCOL PA

Financial Projections CY16E CY17F CY18F CY19F

Net Sales 102.7 163.2 228.2 281.4

Gross Profit 4.7 7.4 8.9 11.0

Operating Profit 2.6 4.0 4.4 5.4

Finance Costs 0.5 0.5 0.6 0.6

Profit Before Tax 2.1 3.4 3.8 4.9

Profit after Tax 1.3 2.4 2.7 3.4

Key Ratios CY16E CY17F CY18F CY19F

EPS 10.4 19.7 22.0 28.2

DPS 5.3 9.8 11.0 14.0

P/E 35.9 19.0 16.9 13.2

Div. Yield 1% 3% 3% 4%

GP Margin 5% 5% 4% 4%

NP Margin 1% 1% 1% 1%

Source: Company Accounts, Insight Research

We recommend 'SELL' with Dec 2017 DCF based Target

Price of PKR354, providing 5% price downside

BUY HOLD SELL

Valuation parameters

Risk free rate 8%

Beta 1.2

Terminal growth 5%

Market risk premium 6%

Cost of equity 14%

Target Price (PKR) 354

Source: Ins ight Research

Sensitivity of TP to valuation parameters

354 4% 5% 6% 7%

13.5% 358 387 423 470

14.0% 344 369 401 441

14.5% 331 354 382 417

15.0% 319 340 365 396

Source: Insight Research

Green = Buy *Black= hold Red = Sell

Terminal Growth Rate

Cost of

equity

21

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Focus on storage capacity to eradicate supply concerns

In order to keep the supply situ[tion smooth, HASCOL h[s invested

[ggressively in developing their stor[ge c[p[cities. Currently, the comp[ny’s

tot[l stor[ge c[p[city is over 100k tons spre[d [cross the country where m[in

loc[tions include Shik[rpur, M[chike, Ke[m[ri, Port Q[sim, D[ul[tpur [nd

Mehmoodkot. Addition[lly, the comp[ny’s stor[ge units [t S[hiw[l (7,500

tons), Kottl[ J[m (6,000 tons) [nd Th[li[n (50,000 tons) [re currently under

construction [nd [re expected to be [dded in 2016.

Lubricants business could contribute PKR3.6/share

Recently, the comp[ny h[s [nnounced its upcoming investment of PKR1.8b in

Lubric[nts [nd Gre[se pl[nt which is likely to come online by CY2018. After

[lre[dy conquering consider[ble m[rket sh[re in the white oil segment, the

m[n[gement is set to penetr[te the higher m[rgins (14-16%) segment.

Assuming, 6% m[rket sh[re in the lubric[nts division by CY2017, the division

could contribute PKR3.6 to the bottom line.

Vitol’s investment has boosted investor’s confidence

Vitol, the world’s le[ding energy supplier, h[s exercised their c[ll option to

incre[se investment in HASCOL from 15% to 25%. On the b[ck of this news,

the stock r[llied showc[sing investors’ incre[sed confidence in the scrip. We

believe str[tegic p[rtnership with Vitol will [lso further er[dic[te [ny supply

concerns which could further support H[scol’s volumes. Further, the comp[ny

pl[ns to build 200k tons of stor[ge c[p[city [t Port Q[sim in [lli[nce with

Vitol.

However, fierce competition ahead; New OMC licenses issued

Although the growth story is convincing [nd we expect HASCOL to continue

incre[sing their m[rket sh[re, recent gr[nting of OMC licenses to new OMC

h[s potenti[l to ch[nge the situ[tion dr[stic[lly where the m[rket sh[re w[r is

further likely to intensify. In such [ situ[tion, it is likely to get more difficult for

HASCOL to continue [t the s[me p[ce of growth. Further, previously,

HASCOL h[s gobbled up PSO’s m[rket sh[re in both the ret[il fuels. However,

this is likely to becoming more difficult [s the OMC gi[nt h[s r[mped up their

ret[il outlets [nd is looking to come with [ more [ggressive [ppro[ch.

Ag[in, we reiter[te, th[t we do expect the comp[ny to further exp[nd

[ggressively [nd conquer 13.1%/14.6% sh[re of m[rket in MS/HSD by

CY2020, but we expect the p[ce to slow down following stiff competition.

Trading at an expensive 2018 & 2017 P/E of 16x & 13.3x respectively.

Currently, the comp[ny is tr[ding [t [ CY2016 P/E of 17x, which is

consider[bly higher th[n 10.4x [ver[ge of the peers. Even on 2018 [nd 2017

e[rnings, the comp[ny is tr[ding [t 16x [nd 13.3x P/E, respectively. Simil[rly,

the P/B multiple CY2016 of 6x [lso shows stretched v[lu[tions. Simil[rly, on [

tr[iling twelve month b[sis, HASCOL is currently tr[ding [t the third highest P/

E (36.7x) when comp[red to 21 s[mple comp[nies in our region. Hence,

[lthough the growth story is convincing, we recommend [ ’SELL’ on the scrip.

0

5

10

15

20

25

P/E

P/B

v

HASCOL Peers

Source: Company Accounts, Insight Research

HASCOL vs Peers (CY2017 P/E & P/Bv)

x

0

10

20

30

40

P/E

P/B

v

Domestic (ex-HASCOL)

Regional

HASCOL

Source: Bloomberg, Insight Research

HASCOL vs Regional Peers (TTM P/E)

x

0

50

100

150

200

250

300

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Jul-

16

Au

g-1

6

Sep

-16

Oct

-16

No

v-1

6

De

c-1

6

Jan

-17

Hascol KSE-100

Source: PSX, Insight Research

HASCOL vs. KSE100

22

PAKISTAN INSIGHT

FEBRUARY 7, 2016

0

8

16

24

32

40

CY14 CY15 CY16E CY17F CY18F CY19F CY20F

EPS DPS

EPS vs DPS (PKR)

Source: Company accounts, Insight Research

0%

3%

6%

9%

12%

15%

150350550750950

1,1501,3501,550

Volume (000 tons)

Mkt. Share (%) (RHS)

Mogas sales volume vs market share

Source: Company accounts, OCAC, Insight Research

4%

6%

8%

10%

12%

14%

16%

300

500

700

900

1,100

1,300

1,500Volumes (000 tons)

Mkt. Share (%) (RHS)

HSD sales volume vs market share

Source: Company accounts, Insight Research

2%

4%

6%

8%

2

4

6

8Volumes (000 tons)

Mkt. Share (%) (RHS)

Non-Energy volumes vs market share

Source: Company accounts, Insight Research

0

100

200

300

400

500

600

CY1

3

CY1

4

CY1

5

CY1

6E

CY1

7F

CY1

8F

CY1

9F

CY2

0F

Source: PSX, Insight Research

Hascol retail outlets growth

29%

40%

31% MS

HSD

FO

Source: OCAC, Insight Research

HSD accounts for 40% of Hascol's sales

23

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Financial Snapshot

Hascol PetroleumINCOME STATEMENT (PKR m) CY2014 CY2015 CY2016E CY2017F CY2018F CY2019F CY2020F

Net Sales 84,914 76,857 102,849 163,328 228,350 281,622 329,296

Cost of Sales 82,877 74,018 98,199 161,770 227,494 281,059 329,338

Gross Profit 2,037 2,839 4,650 7,367 8,918 10,966 12,780

Operating Expenses 1,207 1,503 2,266 3,546 4,742 5,738 6,648

Operating Profit 1,129 1,546 2,567 3,975 4,353 5,432 6,347

Financial Charges 264 350 503 532 552 567 588

Profit Before Tax 865 1,197 2,064 3,442 3,801 4,865 5,760

Taxation 225 63 810 1,067 1,142 1,460 1,728

Profit After Tax 640 1,133 1,255 2,375 2,659 3,406 4,032

EPS 5.3 9.4 10.4 19.7 22.0 28.2 33.4

DPS 2.2 4.7 5.3 9.8 11.0 14.0 16.8

BALANCE SHEET (PKR m) CY2014 CY2015 CY2016E CY2017F CY2018F CY2019F CY2020F

Share Capital 906 1,207 1,207 1,207 1,207 1,207 1,207

Reserves 1,873 3,322 3,943 5,142 6,473 8,189 10,200

EQUITY 2,779 4,529 5,150 6,349 7,680 9,396 11,407

Surplus on revaluation 321 1,257 1,159 1,043 939 845 761

Long term finances 279 176 2,068 2,000 2,000 2,000 2,000

Liabilities against assets subject to finance lease 49 323 404 505 631 788 986

Others 132 163 183 176 166 163 160

LONG TERM LIABILITIES 459 662 2,655 2,681 2,797 2,952 3,145

Trade and other payables 8,103 17,356 24,550 28,310 35,262 39,348 42,814

Short term borrowings 1,272 1,413 1,201 1,261 1,135 1,022 919

Others 2,684 1,402 1,174 1,133 1,056 1,060 1,079

CURRENT LIABILITIES 12,059 20,171 26,925 30,704 37,453 41,429 44,813

EQUITY & LIABILITIES 15,617 26,619 35,889 40,777 48,869 54,622 60,125

PP&E 3,291 6,278 8,814 11,223 12,562 13,692 14,527

LT-investments 782 1,955 2,053 2,156 2,264 2,377 2,496

Others 570 470 462 456 452 449 447

TOTAL FIXED ASSETS 4,642 8,703 11,329 13,835 15,278 16,517 17,469

Stock-in-trade 3,474 8,470 9,416 11,523 17,452 20,791 23,460

Trade debts 4,549 4,264 5,914 6,533 6,850 7,041 7,409

Cash & Bank Balances 1,761 4,072 7,874 7,812 7,966 8,680 9,946

Others 1,192 1,110 1,356 1,073 1,324 1,594 1,841

CURRENT ASSETS 10,975 17,916 24,560 26,941 33,591 38,105 42,656

ASSETS 15,617 26,619 35,889 40,777 48,869 54,622 60,125

Source: Company Accounts, Insight Research

24

PAKISTAN INSIGHT

FEBRUARY 7, 2016

With industry wide soaring white oil volumes, recent deregulation of HOBC

and pickup in economic activity, we expect the global giant, SHEL, to enjoy its

share of benefits from the recent developments. SHEL’s global focus on higher

grade fuel is set to bode well for SHEL Pakistan as the country has finally

moved to RON 72 and RON75/76 grade fuels. With RON72 now available

across the country, we expect HOBC sales to confine to quality conscious

customers which would provide SHEL with a competitive advantage given

their global presence and a recognized brand name.

SHEL has previously been subject to extremely high tax rates (61% effective

tax rate in CY2015) as the company fell under the turnover tax bracket due to

low profit margins. Heavy inventory losses also kept the company’s earnings

under pressure in the past few years. Both these issues are now subsiding

where SHEL could record CY16 EPS of ~PKR40.

With growing competition, SHEL’s management’s has increased focus on

provision of value added services and has recently signed MOU with Al-

Shaheer Corporation (ASC) to increase footfall on their retail outlets which

would bode well for the company’s retail fuel sales as well as the lubricants

division. Currently, the scrip is trading at a trailing P/E multiple of 13.5x.

Strong brand name to pose beneficial following deregulation of HOBC

Currently, deregul[ted HOBC s[les [ccount for 1% of the tot[l petrol s[les

while SHEL [ccounts for the 26% of th[t. In such [ scen[rio, SHEL’s glob[lly

recognized br[nd n[me should provide competitive [dv[nt[ge where we see

SHEL’s sh[re of HOBC s[les to incre[se. However, with RON72 now [v[il[ble,

we believe th[t the use of HOBC will confine to qu[lity conscious customers

only. Currently, HOBC is selling [t [n [ver[ge ret[il price of PKR85 in the

country, providing SHEL with ~PKR12-15 profit per liter. With the current level

of s[les, this t[llies up to PKR155m [nnu[lly, 4% of SHEL’s CY2016E profits.

Unused tax losses of PKR5.3b could keep tax expense mute

Previously, SHEL rem[ined [ victim of m[ssive effective t[x r[te (61% in

CY2015) [s the comp[ny w[s subject to 0.5% of turnover t[x. Now, with low

prices of ret[il fuels, the profit m[rgins h[ve improved which could shift the

comp[ny to corpor[te t[x r[te. In f[ct, SHEL’s effective t[x r[te declined from

83% in 7MC2015 to 16% in 7MCY2016. Owing to extremely high t[x r[tes in

the p[st, SHEL h[s [ccumul[ted deferred t[x [ssets of PKR5.3b (PKR47/sh[re),

which could keep the comp[ny’s t[x expense muted in the coming ye[rs.

Value added services on outlets to increase footfall

SHEL h[s incre[sed their focus on providing v[lue [dded services [t their ret[il

outlets [nd h[ve recently signed [n MOU with Al-Sh[heer Corpor[tion (ASC)

to coll[bor[te in their ret[il business in P[kist[n. Under the terms,

opportunities to open MOU outlets [t Shell st[tions will be looked into. We

believe this is likely to bode well for the comp[ny’s ret[il s[les [nd could help

them c[pture higher m[rket sh[re.

Brand name to provide multiple benefits in new environment

Shell Pakistan

Shell PakistanCurrent Price 530.1

Market cap PKR m 56,723

Market cap US$ m 540

Free Float Market cap US$ m 108

30-day Avg. turnover m Shares 0.1

30-day Avg. turnover PKR m 54

Shares Outstanding m 107

Free float % 20%

Major Sponsors

Bloomberg Ticker SHEL PA

Financial Projections CY14 CY15 9MCY16

Net Sales 250,785 197,128 134,954

Gross Profit 7,581 10,595 10,242

Operating Profit 452 2,060 3,767

Finance Costs 447 299 145

Profit Before Tax 546 2,345 4,129

Profit after Tax (1,067) 911 3,422

Key Ratios CY14 CY15 9MCY16

EPS (10.0) 8.5 32.0

DPS 8 10 6

P/E - 62 17

Div. Yield - 2% 6%

GP Margin 3% 5% 8%

NP Margin -0.4% 0.5% 3%

Shell London

Source: Company Accounts, Insight Research

0

50

100

150

200

250

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Jul-

16

Au

g-1

6

Sep

-16

Oct

-16

No

v-1

6

De

c-1

6

Jan

-17

SHEL KSE100

Source: PSX, Insight Research

SHEL vs KSE100

25

PAKISTAN INSIGHT

FEBRUARY 7, 2016

Apart from the industry wide soaring white oil volumes, APL is also set to

benefit from sales of Asphalt which are set to experience a boost following

high demand from infrastructural development as well as CPEC related

activities. However, the company’s declining focus on retail fuels has led to

decline in market share from 7.6% in FY2015 to 6.6% in FY2016. Recently,

OGRA has granted construction licenses to 21 new players which is expected

to further intensify the battle for market share, where APL’s inability to

maintain their share is a major threat where further competition could make

the situation worse. Currently, the stock is trading at a trailing P/E of 10.4x.

CPEC and infrastructural development to boost Asphalt sales

APL is currently the only OMC currently which m[rkets Asph[lt (Bitumen),

which, being [ deregul[ted product, enjoys higher m[rgins th[n the ret[il fuels.

The comp[ny’s m[n[gement’s focus on Asph[lt s[les h[s come [t [n expense

to their ret[il fuel m[rket sh[re which h[s declined from 7.6% in FY2015 to

6.6% in FY2016.

Despite of this, we st[y optimistic th[t the comp[ny’s strong presence in

Bitumen (used for construction/co[ting of ro[d surf[ce), is likely to bode well

in the current scen[rio where country wide construction boom, infr[structur[l

development [nd CPEC rel[ted projects [re likely to keep the dem[nd numbers

upbe[t. In CPEC [lone, the tot[l ro[d network st[nds [t north of 2,600km,

which is likely to push the dem[nd up or Bitumen. Moreover, construction of

highw[ys [nd motorw[ys throughout the country will [lso le[d to incre[se in

dem[nd for the product. In such [ scen[rio, APL st[nds to be the biggest

benefici[ry, given their monopoly in Bitumen s[les.

Company lagging in market share war

Owing to competition from sm[ller pl[yers [s well [s comp[ny’s focus on

Asph[lt s[les, APL h[s lost consider[ble m[rket sh[re which h[s declined from

7.6% in FY2015 to 6.6% [t the end of FY2016. Recently, OGRA h[s gr[nted

construction license to 21 new pl[yers which [re set to invest PKR10.5b ([s

per news flows) in filing st[tions [s well [s stor[ge depots. Accordingly, APL’s

in[bility to compete in the intense m[rket sh[re situ[tion is [ m[jor thre[t

where the comp[ny c[n loose further sh[re to sm[ller pl[yers, speci[lly if they

[dopt [n [ggressive str[tegy, simil[r to HASCOL.

Focus on supply chain management to ensure smooth supply

APL h[s employed s[tellite tr[cker-equipment in fleet vehicles [s [ step to

incre[se effectiveness [nd ensure better supply ch[in m[n[gement. Further,

construction of Mehmood Kot [nd Shik[rpur termin[ls [re in the pipeline

where the procurement of l[nd in S[hiw[l [nd D[ul[tpur h[s been completed.

Moreover, APL is p[rtnering with PSO for developing [ fuel f[rm (c[p[city of

10k tons of Jet fuel) [nd into-pl[ne f[cility [t Isl[m[b[d Intern[tion[l Airport

which is expected to be completed in the current fisc[l ye[r.

Declining market share in retail fuels but focus on Asphalt sales

Attock Petroleum Limited

Attock PetroleumCurrent Price 649.6

Market cap PKR m 53,881

Market cap US$ m 513

Free Float Market cap US$ m 103

30-day Avg. turnover m Shares 0.2

30-day Avg. turnover PKR m 138

Shares Outstanding m 83

Free float % 20%

Major Sponsors

Bloomberg Ticker APL PA

Financial Projections FY14 FY15 FY16

Net Sales 205,163 171,730 109,234

Gross Profit 5,942 4,927 5,749

Operating Profit 5,381 3,886 4,985

Finance Costs 134 132 200

Profit Before Tax 5,907 4,538 5,633

Profit after Tax 4,327 3,286 3,829

Key Ratios FY14 FY15 FY16

EPS 52.2 39.6 46.2

DPS 38 35 40

P/E 12 16 14

Div. Yield 6% 5% 6%

GP Margin 3% 3% 5%

NP Margin 2% 2% 4%

Pharon Investment

Source: Company Accounts, Insight Research

80

100

120

140

160

180

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Jul-

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Au

g-1

6

Sep

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Oct

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No

v-1

6

De

c-1

6

Jan

-17

KSE100 APL

Source: PSX, Insight Research

APL vs KSE100

26

PAKISTAN INSIGHT

FEBRUARY 7, 2016

IMPORTANT D ISCLAIMER AND DISCLOSURES

Disclaimer: This report h[s been prep[red by Insight Securities (Private) Ltd, formerly Pardesi Securities (Pvt.) Limited, (herein[fter referred [s ‘ISL’) [nd

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prospects m[y not be re[lized while [ll such inform[tion [nd opinions [re subject to ch[nge without notice. ISL recommends investors to inde-

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• Discounted cash flow (DCF, DDM)

• Relative Valuation (P/E, P/Bv, P/S etc.)

• Equity & Asset return based methodologies (EVA, Residual Income etc.)

Frequently Used Acronyms

TP T[rget Price DCF Discounted C[sh Flows FCF Free C[sh Flows

FCFE Free C[sh Flows to Equity FCFF Free C[sh Flows to Firm DDM Dividend Discount Model

SOTP Sum of the P[rts P/E Price to E[rnings r[tio P/Bv Price to Book r[tio

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EPS E[rnings per Sh[re DPS Dividend per Sh[re DY Dividend Yield

ROE Return on Equity ROA Return on Assets

27

PAKISTAN INSIGHT

FEBRUARY 7, 2016

ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES

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